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Spotlight on the States: Public Pension Reform

Jan 23, 2012

Continuing their efforts to close budget gaps, states across the country have looked to public pension reform as part of a possible solution. Among the states considering such reforms are Illinois, California and New York.

Illinois has been dealing with the issue of public pension reform for a few years now. In 2010, the state passed a reform bill that made various changes to the system for new employees, including raising the retirement age to 67 and increasing the number of earning years pensions are based off from the highest four to the highest eight. Earlier this year, Illinois took another step to improve the state's pension system. On January 5th, Gov. Pat Quinn (D) signed legislation aimed at ending so-called "double dipping" -- instances where state employees took leaves and went to work for unions, but continued to accrue benefits in the state’s pension system based on union pay.

While these reforms have made progress, much more remains to be done on the fiscal front. Earlier this month, Moody’s Investors Service downgraded Illinois’ bond rating from A1 to A2, making it the lowest-rated state in the country (rating agencies S&P and Fitch have California as the lowest-rated state, with Illinois one notch above). In their report, Moody’s stated that "severe pension under-funding" was a key factor in their decision. On a more positive note, a release from Fitch Ratings on January 17th stated that the agency "believes that steps toward improving the status of the state of Illinois' underfunded pension liabilities could be taken during the course of the next year," while still touching on the concerning fiscal projections.

Out west, the state of California is also wrestling with reforms to its public pension system. In his "State of the State" address on January 18th, California Gov. Jerry Brown (D) stated that:

As for pensions, I have put forth my 12 point proposal. Examine it. Improve it. But please take up the issue and do something real. I am committed to pension reform because I believe there is a real problem. Three times as many people are retiring as are entering the workforce. That arithmetic doesn’t add up. In addition, benefits, contributions and the age of retirement all have to balance. I don’t believe they do today. So we have to take action. And we should do it this year.

Released on October of last year, Gov. Brown’s 12-point pension reform plan would apply to all state, county and municipal workers in California and, according to a press release, if fully implemented would cut the cost to taxpayers of providing pensions for state employees in half. The plan includes the following changes:

Raising employee contribution level to at least half of costs

Creating a new mandatory hybrid retirement system that would include a defined-benefit component as well as a 401(k) style plan

Raising retirement age for new hires to 67

Increasing the number of earning years pensions are based off of from the single highest year to the highest 3 years (this has already been put into effect for new state employees)

Requiring more years of state service for new workers to become eligible for health care benefits at retirement (15 years for the state to pay a portion of premiums, 25 years for the state to pay maximum amount of premiums)

Up in New York, Gov. Andrew Cuomo's (D) proposed budget for FY 2012-2013 includes several reforms to the state's public pension system. His proposal would, among other things, increase employee contributions, raise the retirement age, and create a new option in the system that would allow new state workers to choose between a defined contribution plan or a pension with benefits less than those offered now. These reforms would reduce pension costs by one half compared to the current benefit design, and save public employers outside of New York City $83 billion over 30 years (New York City's savings would be $30 billion over 30 years). NYC Mayor Mike Bloomberg voiced his approval of Gov. Cuomo's focus on reforming the state's pension system, saying in his "State of the City" speech on January 12th that "Governor Cuomo is right to make pension reform a top priority, and he’ll have our full support."

For all of these states, as well as many others, structural and long-term reforms to public pension systems could go a long way toward improving their fiscal outlook. Like all important aspects of the budget, however, the issue of public pension reform can be a political minefield. Hopefully, state government officials will work together to reduce the burden pension systems place on state budgets and taxpayers, while still ensuring a stable financial future for government workers.